Court of Appeals of the State of Washington: Bad Faith Damages May Exceed the Amount of a Reasonable Covenant Judgment

The Court of Appeals of the State of Washington held that a reasonable covenant judgment, consisting of the total liability of the insured to outstanding claimants, represented the minimum amount of damage suffered by an insured when his insurer failed to settle the claims in good faith.

On August 23, 2000, Patrick Kenny was driving with three friends on a road trip when he rear-ended a cement truck. All three of the passengers, Ryan Miller, Ashley Bethards, and Cassandra Peterson, were injured in the collision. The vehicle Kenny drove belonged to Cassandra Peterson and was insured under a Safeco insurance policy held by Peterson’s parents.

After the accident, Miller, who experienced a head injury, contacted Safeco to inquire about the insurance policy limits, which Safeco refused to disclose. Miller subsequently filed suit against Kenny on December 20, 2001 in order to make the limits discoverable. Safeco undertook Kenny’s representation without a reservation of rights and eventually Safeco disclosed the policy limits, which included $500,000 in liability coverage and umbrella policy limits of $1 million.

Miller contacted Safeco in an attempt to settle for the policy limits, giving the insurance company fair warning of a “substantial risk of an excess judgment.” Peterson also sent a demand letter to Safeco, requesting settlement for $350,000. Not long after, Bethards demanded $1.25 million from Safeco.

Kenny’s appointed defense counsel, Vickie Norris, realized at this point that the cumulative settlement demands from the passengers exceeded Safeco’s policy limits. She reached out to Safeco’s insurance adjuster on August 29, 2002 to demand that Safeco tender its policy limits in order to settle the pending claims. Safeco, however, refused to settle, disagreeing with Norris that the damages exceeded policy limits, and released only $500,000. Norris unsuccessfully attempted to negotiate a settlement with the three claimants using these funds.

Later in March 2003, after Miller’s suit against Kenny had been set for trial, Safeco authorized Norris to tender the remaining $1 million in umbrella policy limits, along with the $500,000 limit of liability. By this point, though, Kenny was already attempting to reach a global settlement agreement with all three of the claimants. Kenny’s agreement with the three passengers was finalized in May 2003. Kenny used the insurance proceeds from Safeco as well as other proceeds from a State Farm policy owned by his parents to negotiate a settlement for $1.8 million to be divided among Miller, Bethards, and Peterson. Additionally, Kenny assigned to Miller Kenny’s rights to any bad faith claims against Safeco. In exchange, the three claimants agreed to not enforce any excess judgment against Kenny, which would later be determined by stipulation.

After learning of the settlement agreement, Safeco intervened to stipulate to an order that $4.15 million was the reasonable net amount of the stipulated covenant judgments. This number represented the total outstanding damages of the three claimants after deducting what they all received from the $1.8 million in insurance proceeds. All parties, including Safeco, agreed to the stipulation, which would treat the $4.15 million as if judgment had been entered against Kenny. Safeco, nevertheless, reserved defenses in the event of future litigation.

Subsequent to the agreement, Miller dropped his claims against Kenny and amended his complaint to pursue bad faith claims against Safeco as Kenny’s assignee. Miller alleged that Safeco’s failure to disclose policy limits led to the suit against Kenny and amounted to a failure to protect Kenny from an excess judgment. At trial, Miller argued that if Safeco had tendered its policy limits earlier, it would have avoided placing its insured in such a precarious position. Safeco countered that Miller was responsible for the delay in settlement by making excessive demands.

Ultimately, the jury found Safeco liable for $13 million on the bad faith claim. Prejudgment interest of $7 million, $1.7 million in attorney’s fees and costs, as well as treble damages under the Consumer Protection Act brought Safeco’s total liability to over $21.8 million. Safeco appealed this verdict, raising a host of issues.

Prior to trial, Miller moved for partial summary judgment to establish that the $4.15 million stipulated order merely set a floor for damages as the reasonable amount of the covenant judgment, or in other words, only represented “the minimal amount of harm if Safeco is liable.” The jury was thus instructed that if Safeco were found liable, the jury must include at least the $4.15 million stipulated order in its damages calculation and should consider other damages beyond this. The jury awarded $7.75 million on top of the $4.15 million. Safeco argued that the jury should not have been allowed to award damages beyond what was agreed to in the stipulated order. Safeco further contended that Kenny suffered no harm because the covenant contained a promise by the claimants not to execute on an excess judgment against Kenny.

The court rejected Safeco’s argument, noting that once bad faith has been established, a rebuttable presumption of harm arises. The court pointed out that Kenny was not released from liability; rather the agreement merely indicated that the other claimants would seek recovery from other assets, namely the insurance proceeds and Kenny’s assignable bad faith claims. According to the court, “if an insurer acts in bad faith, an insured can recover from the insurer the amount of a judgment rendered against the insured, even if the judgment exceeds contractual policy limits.” Safeco instead argued that language from prior cases describing a covenant judgment as the “presumptive measure of an insured’s harm” limited an insured’s recovery to the amount of a reasonable covenant judgment. The court disagreed, finding the measure of harm to the insured is “presumptively worth at least the amount of the covenant judgment—not less.”

Explaining the rationale behind this rule, the court noted that an insured’s damages are not limited solely to his or her liabilities to third parties captured in a reasonable covenant judgment. Rather, an insured may suffer damages caused solely by the insurer’s bad faith. These damages may include a detrimental impact on the insured’s credit rating, damage to reputation, loss of control of the case, attorney fees, other financial penalties, and even emotional distress. The court also pointed out that in a bad faith case, an insured is not limited to economic damages. Accordingly, the court upheld the trial court’s instruction allowing the jury to consider additional damages beyond what was encompassed by the stipulated order.

On appeal, Safeco also called attention to discovery-related issues stemming from the bad faith verdict. One of these issues concerned Safeco’s efforts to depose Miller’s attorney, who Safeco accused of deliberately forestalling settlement to set up a bad faith claim. Safeco’s attempt to question Miller’s attorney invoked matters covered by the attorney-client privilege and the work product doctrine. The court quickly disposed of Safeco’s argument, noting that pushing for a policy limit settlement was the attorney’s “professional responsibility,” and that keeping bad faith litigation as a possible backup strategy was not an unfair practice.

In another line of argument, Safeco contended that evidence of its reserves should have been excluded as irrelevant or prejudicial. The evidence demonstrated that Safeco knew that Kenny was exposed to liability well beyond policy limits each time it reviewed its reserves. According to the court, evidence of reserves in a personal injury suit is generally irrelevant and cannot be admitted to show liability. Yet, in bad faith litigation, “reserves may be relevant and admissible where the issue is whether the insurance company fulfilled its duty to adjust the insured’s claim in good faith.” Typically, policy concerns warrant excluding this type of evidence, but here the court made an exception because “the discrepancy between Safeco’s loss reserves and its settlement posture was enduring and sizable.”

As a final matter, Safeco objected to the trial court’s failure to exclude deposition testimony of one of its claims analysts, Maryle Tracy, as irrelevant and prejudicial. At trial, the jury was shown a videotaped deposition of Tracy, in which she admitted that Safeco employed programs to reward its employees for keeping costs down. Upon review, the court found that this testimony was admissible and relevant to the bad faith claim. According to the court, “[t]he existence of these programs and the action by a claims analyst to conceal them supplied evidence of Safeco’s motive to avoid settling for policy limits.”

After entertaining Safeco’s remaining objections, the Court of Appeals affirmed the jury’s verdict and denied Safeco’s motion for a new trial.

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